Clean Up Financial Statements before Searching for a Buyer

By Jay Sickler

The first step in selling any business is putting its financial house in order.

After years of hard work, small business owners often want to cash out. While it’s inevitably an emotional decision, several easy steps can make the process go much smoother.

First, put our house in order. A business isn’t ready to be sold until it’s dressed for the party. That means cleaning up your books and financial statements. Potential buyers will assess the worth of your business based on reported earnings, not your representations of what the company “should earn” in the hands of the new owner.

If you’ve allowed a high level of perks and non-essential expenses, it’ll have a negative impact on the value of your business. Buyers believe the financial statements, not promises from the owner.

After eliminating discretionary expenses from your financial statements, it’s helpful to ask a series of questions regarding the sale of the business.

First, who’s the likely buyer? A family member? Someone on your management team? A competitor? A supplier?

There are challenges to each type of buyer. For instance, a family member may not have much money for a down payment. A competitor is not generally someone with whom you want to disclose sensitive financial information.

Next, what determines, the value of a business? The value of a business is prospective, or future-looking. The most recent financial year is most relevant. Try not to sell your business after a down year. Not only will the value be reduced due to lower earnings, but the buyer may want to lower the price even more because of the slowdown.

A prospective buyer may also be interested in the company’s tangible assets. The value of a company is equal to the value of its tangible assets, such as accounts receivable, inventory, and fixed assets, plus the value of its intangible assets, such as goodwill.

If a buyer needs to obtain bank financing, the value of the tangible assets is quite important for collateral purposes.

Next, does the value of your business change depending on the buyer? It can, but buyers are generally reluctant to pay for what they will bring to your business.

A competitor, or someone already in the industry, may have the ability to enhance the cash flow of your business by increasing sales or reducing expenses. This would be due to their customer base or their ability to cut expenses.

Are there circumstances in which a certain type of buyer would pay more? Possibly, if your business is a strategic fit, or if the buyer is motivated to eliminate you as a competitor. Because of the importance of the purchase, a strategic buyer may be willing to share some of the expected increased earnings with a seller.

What information is relevant to a buyer? Prospective buyers generally require several years of financial statements. As mentioned, the most recent year is typically most relevant to a buyer. It’s also best to have financial statements issued from an independent accounting firm, whether audited, reviewed, or compiled.

A buyer also needs to understand how the seller has been compensated by the business, and how much time the seller spends actively working in the business.

Since cash flow is ultimately most important to a buyer, many buyers combine pre-tax net income, owner’s salary and bonus, owner perks, depreciation, and other non-cash expenses, such as seller’s discretionary cash flow, to measure an acquisition target’s earnings. Generally, the higher the seller’s discretionary cash flow, the higher the value of the business.

Selling your business is a process that takes planning and a thoughtful approach. Unlocking the full value of your business will not come by chance, so start the process early to reap the full measure of your life’s work.